Thursday, February 14, 2013

Abenomics Spurs a Global Macro Lovefest?

For an elite group of the world’s most successful and secretive hedge funds, only one bet has mattered for the past three months: the “Abe trade”.

Shorting yen and buying Japanese equities, inspired by the dovish monetary bent of Japan’s new prime minister, Shinzo Abe, has been one of the most successful hedge fund wagers in years.

And many believe it is a harbinger of greater macroeconomic dislocations and greater opportunities.

Since 2010, the blue-bloods of the world’s $2tn hedge fund industry – so-called global macro managers – have been cowed by rangebound markets that have been dominated by choppy “risk on, risk off” movements. Global macro stars, who specialise in trading interest rates, bonds and currencies to play the ups and downs of the world economy have not just struggled to make money, they have struggled not to lose it.

Indeed, according to Hedge Fund Research, the average global macro specialist made just 3.5 per cent in the three years to November 2012.

But thanks to events in Japan, the past months have marked a dramatic return to historical form. “The big macro trade right now is shorting the yen, long Japanese equities,” said one fund manager who specialises in macro hedge funds.

Japan was the main topic of conversation at all the new year investment conferences, he added, be it talk of shorting the yen, buying Japanese equities or derivatives on volatility.

Hedge fund giants that piled into short yen positions included Caxton Associates, Moore Capital and Tudor Investment Corporation. All have seen their bets pay off handsomely.

According to information from investors, who declined to be named, Caxton saw its flagship fund make more than 6 per cent in the last two months of 2012. The fund is up a further 4 per cent this year.

Tudor, meanwhile, made 5 per cent in the last two months of the year and a further 4.3 per cent in January.

Moore, which was shaken earlier in 2012 by the departure of its once-feted trader Greg Coffey, made nearly 5 per cent in November and December and was up 3.6 per cent in January.

“The number one driver of P&L for a lot of hedge funds has been Japan,” says Ben Funk, head of research at funds of funds Liongate Capital, which invests money in hedge funds.

“It has definitely been a huge contributor for a lot of funds in the past few months.”

Others that have fared well include the Fortress Investment Group’s global macro fund, which an investor said made close to 5 per cent in the past two months and Pharo Capital’s flagship fund, which made 7 per cent in the same period.

Mr Abe, president of the then opposition Liberal Democratic Party, made clear on several occasions in the run-up to the mid-December general election that he was a strong supporter of greater monetary easing by the Bank of Japan to stimulate growth. With the bank’s governor and two deputy governors set for replacement this year, Mr Abe’s stance pointed towards the possibility of a permanently more dovish BoJ.

“People were hesitant to talk about these trades at first because for so long shorting the yen or JGBs [Japanese government bonds] has been known as a graveyard trade,” says Anthony Lawler, portfolio manager at fund of hedge funds GAM.

“But once a situation materialised where there were some really strong statements [from Mr Abe] in favour of easing, it became a more obvious trade to many seasoned macro managers. It was an asymmetrical trade in one of the world’s deepest, most liquid markets.”

Mr Lawler adds: “It’s fair to say that these opportunities haven’t been abundant. There have been big moves in areas like FX for the past few years, but they haven’t been caught because they haven’t been well telegraphed through policy or they have come as big surprises.”

Well-connected global macro managers are now hopeful that “Abenomics” is the beginning of a trend towards greater volatility and more big, directional moves in global markets.

For many of them, the prospect of “currency wars” and a breakdown in the international economic consensus will make for the kind of investment opportunities they have been desperate for since 2008.

The next few months are rich with potential opportunities, they believe, whether shorting sterling in anticipation of laxer monetary policy from incoming Bank of England governor Mark Carney; buying up equities to trade on institutional investors’ rotation away from bonds; or investing in commodities such as palladium to capitalise on a race for devaluation among the world’s big currencies.

“I think it’s the rebirth of global macro,” says the head of one of the world’s top five global macro hedge funds. “For the last three years we have had this rangebound environment, and now it looks like individual currency actions, individual countries acting, are going to start to dominate.”

There is no doubt about it, the 'Abe trade' has revived global macro funds which were struggling to bring home the bacon in the last few years. Since the beginning of November, the US dollar has risen 17 percent against the yen. Managers hope Japan’s situation foretells a return to the volatile markets in which they succeed.

But is the 'Abe trade' really a harbinger of things to come? In many ways, shorting the yen was one of the most obvious things to do as investors were forewarned of the seismic shift in Japan. I wrote about it back in November and thought a lot of investors would jump on this trade.

Some of the biggest U.S. hedge-fund investors have made billions betting against the yen, exploiting Japan's determination to weaken its currency and boost its economy.

Wagering against the yen has emerged as the hottest trade on Wall Street over the past three months. George Soros, who made a fortune shorting the British pound in the 1990s, has scored gains of almost $1 billion on the trade since November, according to people with knowledge of the firm's positions. Others reaping big trading profits by riding the yen down include David Einhorn's Greenlight Capital, Daniel Loeb's Third Point LLC and Kyle Bass's Hayman Capital Management LP, investors say.

The growing trade has itself helped pressure the yen, which has slid almost 20% in about four months. That, in turn, is helping fuel what could become a world-wide currency war. Countries such as Germany and France have criticized Japan's policies, while others have threatened to take action to reduce the value of their own currencies to remain competitive with Japan. Like Japan, many countries depend on exports, which are more profitable when their own currencies are lower.

Investors began jumping into the trade late last year, ahead of the election of Shinzo Abe as Japan's prime minister. When Mr. Abe and others were unusually open in their rhetoric about driving down the currency, traders added to their positions, helping the yen weaken. Soon, salespeople and traders at banks were telling hedge funds and other investors that the time was right to make big bets against the yen.

Mr. Abe's election, and the selling by hedge funds, had a big impact. On Wednesday, the dollar bought about 93 yen, from about 79 yen in mid-November. "It's a bet on Abe-nomics" someone close to the Soros firm says.

Many others have come to the same conclusion. Among the most vocal proponents of the trade is Robert Ettinger, the head of Bank of America's BAC -0.25% options trading group for currencies in the Group of 10, investors say. Mr. Ettinger has spoken about how he "loves" the bearish yen trade, according to an investor who heard him speak recently. Bank of America's trading desk also has made money on the trade, according to people with knowledge of the firm's positions. Mr. Ettinger declined to comment.

Few investors, though, have made as much money as Mr. Soros. The 82-year-old investor's $24 billion Soros Fund Management has made close to $1 billion of paper profits since mid-November wagering on yen weakness, according to people close to the matter.

The firm, which returned cash to outside investors last year, still invests money for Mr. Soros and his family. It manages about $15 billion itself and allocates the rest to other investors. Soros Fund Management has been led since last summer by Scott Bessent, who increased the yen position late last year. The Soros firm also has done well owning Japanese stocks, which have been rallying. Japanese shares represent about 10% of the firm's internal portfolio, according to people close to the firm.

Betting against the yen isn't for the faint of heart. Japan had for years failed in its efforts to lower its currency and reignite its economy and stock market. Many who adopted short positions on the yen and on Japanese government bonds during that period got pounded when the currency and the bonds instead strengthened. Shorting Japan became known on Wall Street as a "widow maker.""You aren't a macro trader if you haven't lost money betting against Japan," one trader said.

Japan's new economic policies are expected to be widely discussed at this weekend's meeting of the Group of 20 finance ministers in Moscow. This week saw rocky trading in the yen after a series of conflicting reports about whether the smaller Group of Seven nations were supportive of Mr. Abe's policy. After global criticism, Mr. Abe and his advisers have toned down their talk about weakening the yen. Instead, its central bank has promised a significant new easing in monetary policy by buying bonds—similar to strategies enacted by the U.S. Federal Reserve and the European Central Bank—which policy makers say is aimed at ending Japan's long bout of deflation and often has the side effect of lowering a currency.

As quickly as investors raced to short the yen they could just as easily rush to end this trade, sending the currency higher again, especially if investors conclude the Japanese government is backing off its anti-deflation campaign.

Some hedge funds already have been trimming their bearish yen positions. "People recognize there are concerted efforts on hand to end two decades of deflation," Chris Ayton of Alternative Investment Group, which invests in hedge funds for clients. "But I don't see genuine belief out there yet that this time is different. There's still a significant amount of skepticism."

It isn't clear who is feeling pain as the yen falls. Some Japanese exporters with receivables tend to sell dollars and buy yen in the futures market, which could mean they currently are sitting on losses, some traders and analysts say.

"Japanese exporters need to buy yen, and they've been doing that a bit more recently, believing the yen weakness wouldn't last," says David Woo, Bank of America's head of global rates and currencies research.

Shares of exporters have been helped by the recent rally in Japanese stocks, of course. The Japanese economy isn't as export-dominant as it once was, reducing the impact of a falling yen, some analysts argue.

Unlike Mr. Soros's early short of the British pound, the recent moves by Mr. Soros and other hedge funds are unlikely to destabilize Japan or its currency, partly because trading of Japanese yen is a deeper market that is harder for investors to dictate. Nearly all of Japan's debt is owned by domestic investors, another reason short positions on the country by bearish investors haven't had much impact.

At the same time, Mr. Soros's gambit against the pound was in opposition to policies of the Bank of England, while hedge funds now are making trades in hopes the Bank of Japan succeeds in its policy of defeating deflation.

Lately, a rush of new investors has become involved in the yen trade. As more investors jump on the bandwagon and search for ways to place their own wagers against Japanese currency, some worry the latecomers may regret their newfound ardor for shorting the yen, much like those who piled into shares of Apple Inc. AAPL +0.05% just before its recent tumble.

Many investors bailed out of earlier bearish-yen trades a while ago, unable to withstand losses they suffered. It is similar to how some mortgage specialists removed long-held bets against subprime mortgages before the housing market finally weakened in 2007. They then missed out on the profits when the market turned.

Others, like Greenlight Capital's Mr. Einhorn, have held on. His firm gained over 3% in January thanks in part to his yen bet.

"We put the trades on about three years ago and the trade wasn't fun for the first two years and number of months," Mr. Einhorn says. He expects further weakness.

Investors have wagered against the yen in various ways, from complicated derivatives to simple put options, the kind that Mr. Einhorn says he bought.

Others have had to switch gears, quickly. Bridgewater Associates, the world's largest hedge-fund firm with $141 billion, had expected strength for the yen for most of 2012, but removed its bullish yen positions in the fourth quarter of last year. Bridgewater is "now modestly short" the yen, according to a January letter to investors.

Below, the WSJ's Jake Lee explains why exploiting Japan's sinking currency can be good and bad for the global economy and how hedge funds made a killing shorting the yen. These funds should thank Shinzo Abe for his special Valentine's gift. Let's see if it's enough for investors to fall back in love with them.

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I am an independent senior economist and pension and investment analyst with years of experience working on the buy and sell-side. I have researched and invested in traditional and alternative asset classes at two of the largest public pension funds in Canada, the Caisse de dépôt et placement du Québec (Caisse) and the Public Sector Pension Investment Board (PSP Investments). I've also consulted the Treasury Board Secretariat of Canada on the governance of the Federal Public Service Pension Plan (2007) and been invited to speak at the Standing Committee on Finance (2009) and the Senate Standing Committee on Banking, Commerce and Trade (2010) to discuss Canada's pension system. You can follow my blog posts on your Bloomberg terminal and track me on Twitter (@PensionPulse) where I post many links to pension and investment articles as well as my market thoughts and other articles of interest.

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